August 7, 2006

Securities Litigation Continues Downward Trend

This recent study on class action securities litigation – “2006 Mid-Year Securities Fraud Class Action Filings Report” – from Stanford Law/Cornerstone Research shows that securities litigation continues to trend downwards with a 45% decline in the number of securities class actions filed during the first half of 2006 compared to the same period of the prior year. We have posted a copy of the study, along with other securities litigation studies, in our “Securities Litigation” Practice Area. Can you believe that only one new securities class action was brought against an audit firm in the first half of 2006?

The Study posits some reasons for this trend, including the dissipation of the ill effects from the boom and bust period of the late ’90s, the cleansing effects of Sarbanes Oxley, and the absence of stock market volatility. Kevin LaCroix of the “D&O Diary” is a bit more cynical and believes that this downward trend is partially due to Milberg Weiss’ troubles and the disappearance of the paid plaintiff.

I believe Kevin’s hunch is correct – but also agree with the Study’s theory that the downward trend probably has been helped along by the morass of regulatory changes wrought by Sarbanes-Oxley, which has provided ample incentive for executives and boards to improve their governance practices. Another factor I would add is the spate of recent court decisions that have raised the benchmarks that must be met for successful cases, such as last year’s US Supreme Court decision of Dura Pharaceuticals.

Given that there were a record number of restatements in 2005 – and I understand that restatements in 2006 are ahead of that pace so far – I would hazard to guess that this downward trend will continue (except perhaps the option backdating lawsuits that are now being filed in droves will reverse the trend).

The Art of Predicting the Securities Law Class Action

In related news, The Corporate Library released an update to its continuing study of the correlation between its corporate governance ratings and the risk of securities class action lawsuits. The findings include:

– Companies rated “D” or “F” are more than 3x as likely to be hit with a securities class action lawsuit than those rated “A,” “B” or “C”
– Excessive CEO compensation is the single most predictive factor of being sued
– Other predictive factors include director age, tenure, over-commitment and lack of independence
– Takeover defenses are less important as a predictive factor
– Nearly all securities class action lawsuits are filed against companies with more than $485 million in market capitalization

A “Stolen” Parachute

What struck me as offensive about the article below from Sunday’s NY Times is not the political angle – but that a CEO got a $28 million severance package when he voluntarily quit his job to run for the US Senate (here is a related LA Times article – and here is the complaint amid other materials from the plaintiff):

“Someone has finally made executive compensation an explicit campaign issue. Emma Schwartzman, who says she is a great-great-granddaughter of a founder of what later became the Safeco Insurance Company, has sued the company’s recently departed C.E.O., Michael S. McGavick — now the Republican candidate for the United States Senate from Washington state — over his $28 million severance package. In her suit, filed in Federal District Court in Seattle, Ms. Schwartzman, 27, said Mr. McGavick was entitled only to his last paycheck and that he had forfeited all other compensation, including bonuses and stock options, when he resigned.

According to the suit, the board agreed to let Mr. McGavick remain on the payroll for an extra four months and then to provide freelance “transition services” for two more months. That agreement, she contends, let Mr. McGavick keep stock options and other compensation that he otherwise would have had to forsake, under the terms of his original employment contract.

Mr. McGavick, who is trying to unseat Maria E. Cantwell, a Democrat, said in a statement that the allegations were ‘without merit and politically inspired.’” Safeco described the departure package as ‘reasonable.’

Ms. Schwartzman’s lawyer, Knoll D. Lowney, said the case was about “corporate corruption, not partisan politics.’ But he also insisted that Mr. McGavick return the money to Safeco and not spend it on his campaign.”

What in the world was the Safeco board thinking when they allowed this severance payment to be made (not to mention keeping him on the payroll, etc.)? Particularly with the SEC’s new executive compensation rules requiring more disclosure about a board’s pay strategies, boards and their advisors should heed the responsible pay wisdom that will be imparted during the “3rd Annual Executive Compensation Conference,” available live in Las Vegas or by nationwide video webcast. Register today!